China is the world’s second-biggest economy, its largest exporter and second-largest importer. Yet its currency, the renminbi (RMB), still accounts for less than 1% of global foreign exchange (FX) turnover. The Chinese authorities have been making concerted efforts since late 2008 to internationalise the currency by attempting to increase its use in international trade and investments. Their efforts are paying off, as international RMB payments and trade settlement have grown since late 2010.
Three FX markets exist for RMB: the onshore yuan (CNY) market, which is tightly controlled; the offshore CNH market in Hong Kong, which is relatively free; and the US dollar (USD)-denominated non-deliverable forward market. Hong Kong is the dominant offshore centre for RMB trading, accounting for around 80% of all RMB payments while the shares of Singapore and Taiwan are also significant. The UK is also positioning itself as a major offshore RMB trading centre.
Despite these developments, there are challenges with China’s efforts to internationalise the RMB. At a broad level, the currency is mostly used to settle imports, but not exports. Even in imports, invoicing is often done in USD while settlement happens in RMB. Some argue that many Chinese corporations use the different currency markets (CNH and CNY) more to engage in speculative activities, and not that much for pure trade purposes. Many of these problems are intertwined as China has traditionally had strict capital controls, and the internationalisation of the RMB is taking place before full liberalisation of its interest rate, exchange rate or capital account.
Lax AML Controls, Strict FX Oversight
Along with the formal inflow of funds, ‘underground banking’ or illicit ‘hot money’ flows are also significant in China. This is primarily due to strict FX controls traditionally imposed by the Chinese authorities. There are few approved channels for transferring yuan across the border, and the quantum of such transfer is also limited. Hong Kong is the main source of illicit money transfers both to and from China. Chinese regulators usually monitor large-value transactions; therefore it is easier to transfer smaller amounts. Because of this, money laundering is a big issue in the southern region of China.
China’s anti-money laundering (AML) framework has been under development for more than 15 years. However, AML regulations were largely inadequate until as recently as 2006-07. Since then, the authorities have taken the issue of money laundering more seriously; the penal code has been amended to include a wider range of activities under money laundering, rules have been formulated for customer identification and account keeping processes, and the scope of AML has been extended beyond the banking sector to include the securities and insurance sectors, as well as non-financial sectors. However, to date the fines imposed on institutions sanctioned for non-compliance have been insignificant.
As a result, the internal control systems and company culture at financiers in China tend to be inadequate, and as yet they do not go beyond meeting basic regulatory requirements. Most of them take a siloed approach towards AML, with rule-based transaction monitoring and elementary training for employees just to avoid regulatory pressure. Often there are no dedicated AML personnel, so these activities are carried out by branch staff in addition to their primary responsibilities. Lack of an integrated operational and technological approach makes real-time detection difficult and restricted to over-the-counter (OTC) activities. However, AML-related issues need to be given due importance, more so in the light of recent developments as a number of firms and financial institutions (FIs) has been heavily fined for lacking adequate AML provisions.
Of late, non-compliance with AML regulation is attracting increasing scrutiny of the Chinese regulator and institutions are slowly waking up to this reality. A number of the more technologically advanced Chinese banks have started to adopt a centralised approach to AML by developing internal guidelines and IT systems, while improving monitoring capabilities and staff training. This could help treasurers looking to do business in the country and find local partners. Foreign banks working in China are generally ahead of the domestic banks. Following their global practices many foreign banks have implemented centralised AML systems and approach this as a business challenge rather than just an operational issue. If the treasurer does not have to worry about this issue it certainly helps.
What’s in a Name: Chinese Characters and Technology
One major technological challenge associated with the RMB internationalisation process is in the use of Chinese names and characters and transliterating them into the Latin alphabet for use in transaction monitoring purposes. Many Chinese characters have the same or similar pronunciation, making it difficult to identify which characters a transliterated name represents.
China’s many dialects, as well as the different naming conventions that exist in various regions within the country, result in many possible transliterations of Chinese names. These are often transliterated using the Chinese Commercial Code (CCC) in international transactions. Limited space in transaction forms results in truncated names, making name matching difficult.
In addition to international sanctions lists local regulators have their own sanctions blacklists, which give rise to more problems. Therefore international transactions with Chinese names often create problems for corporates and banks. This is due to a number of reasons: of them Celent has identified IT system issues and messaging standards issues as among the most common. Counterparties sometimes lack the right capabilities to translate and send Chinese names correctly.
Few banks are addressing these issues seriously at the moment, and most are awaiting the emergence of industry-wide standards and frameworks, which can create problems for treasurers in the financial supply chain. Nor are many of them using technology to address CCC-related issues, which are handled manually by internal teams in more than half of the region’s institutions. Current regulatory requirements regarding CCC are very minimal, if not totally absent. Authorities need to pay greater attention to making them viable.
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